Use Cost Segregation To Your Advantage

Is Cost Segregation Right For You?

In our previous article entitled “Strategies to Minimize Tax Liability for Business Owners” we talked briefly about the advantages of using Cost Segregation to accelerate depreciation on certain portions of both residential, and commercial real property. In this article, we’ll take a look at how, and why it may work for you. Additionally, we will share what you need to do to take advantage of the potential benefits.

As a reminder, Cost Segregation is a means by which owners of property can break out certain aspects of a building, and treat them like personal property for depreciation purposes. This allows you to depreciate a portion of your commercial property over 5, 7, or 15 years, rather than the standard 39 for commercial, or 27.5 for residential.

While certain aspects, like landscaping are fairly simple to document and segregate, you’d miss out on a number of opportunities to take advantage of all available accelerated deductions if you didn’t dig a little deeper. That’s where hiring a construction engineer who is a cost segregation specialist can be well worth the investment.

When to Hire a Professional

A cost segregation specialist can differentiate between elements of the building which are defined as “dedicated, decorative, or removable” versus what’s considered “necessary and ordinary for operation and maintenance of the building”. Assets included in the building cost which may be treated as personal property for depreciation purposes may include:

  • Carpeting and flooring
  • Bathroom fixtures
  • Dedicated cooling systems for machinery
  • Electrical fixtures and lighting
  • Decorative finishes

If you spent more than $750,000 to purchase, or remodel a building since 1987; which for rental and other commercial property is easy to do, HKMP can help you engage a specialist to perform a detailed study to identify components in your building qualifying for cost segregation, and who will provide supporting documentation for your allocations. This can be extremely insightful if you acquired the property.

A cost-segregation specialist will analyze architectural drawings, mechanical and electrical plans, and other blueprints to break out those components eligible for treatment as personal property from those which are structural components of the building. As part of their analysis, they’ll also identify, and allocate things like architecture and engineering fees, and other indirect costs to each element.

Take Full Advantage of TCIA Changes

The Tax Cuts and Jobs Act of 2017 (TCIA) made it even more attractive to identify assets which qualify for Cost Segregation. TCIA increases bonus depreciation on qualifying assets from 50% to 100%. It also allows you to retroactively utilize cost segregation on previously owned properties acquired after September 27, 2017. Prior tax law only applied to new construction, and remodels.

Before 1996, retroactive savings on property added since 1987 had to be realized over 4 years. However, in 1996, the law changed. Thus allowing cost savings to be realized all at once, upon completion of the cost segregation report. Until TCIA was enacted, it only applied to new construction. Taking advantage of Cost Segregation now allows you to claim retroactive deductions for catch-up depreciation on older buildings acquired since September 27, 2017 which didn’t qualify for cost segregation prior to the enactment of TCIA. Additionally, you can claim all the savings in one tax year.

Weigh the Costs and Benefits

By utilizing your cost-segregation specialist’s report, HKMP can ensure you take advantage of every opportunity to reduce your tax liability by adjusting the timing on your depreciable assets.  Advantages include:

  • Increased cash flow in years when costs are higher
  • Revisiting properties purchased used which were previously ineligible for cost segregation
  • Identifying opportunities to take advantage of catch-up depreciation
  • Possible reduction to real estate taxes by shifting costs away from real property
  • Potential increase in deductions for sales and use tax
  • Documentation of your re-allocations in the event of IRS inquiries

Please keep in mind, when you’re re-allocating assets you’ve depreciated in prior years, you could create a liability for recaptured depreciation. This could trigger understatement penalties, especially if you’re overly aggressive in your use of cost segregation. Also, cost segregation reports do have a cost. Therefore, it’s a good idea to weigh the potential benefits before any study is done.

HKMP can help weigh the costs and benefits of reallocating assets identified in your cost segregation report. Allowing you to make informed and intelligent decisions, and reallocate costs for the best possible outcome.

Rental Property and Qualified Business Income

Are You Maximizing Your QBI Deduction?

If you’ve invested in real property, you’re probably using every opportunity you can to offset the income with expenses, so you don’t eat up the property’s cash flow with taxes. But are you doing everything you can to minimize your liability? If you’re not taking advantage of the QBI (Qualified Business Income) deduction, not only are you missing out on an opportunity, but your tax bill is higher than it should be.

As an investor in rental property, you’re probably already aware of the usual, allowable deductions available to you such as:

  • Advertising
  • Telephone and Internet
  • Repairs and Maintenance
  • Utilities
  • Employees
  • Interest
  • Etc.

You might also be taking advantage of special depreciation options discussed in a recent article entitled “Strategies to Minimize Tax Liability for Business Owners” including:

  • Section 179
  • Bonus Depreciation
  • Cost Segregation

What the Tax Cut and Jobs Act (TCJA) Means to You

You can maximize your QBI deduction on property held for lease or rental by taking advantage of the 20% pass-through deduction available through section 199A, which was introduced as the TCJAof 2017? Section 199A allows owners of certain pass-through businesses to deduct part of their qualified business income from a qualified trade or business.

What this could mean to you is a deduction of up to 20% of qualified business income if your rental property is held by a qualified trade or business, and you meet certain thresholds. On September 24, 2019, Revenue Procedure 2019-38 added:

“…a safe harbor allowing certain interests in rental real estate, including interests in mixed-use property, to be treated as a trade or business for purposes of the qualified business income deduction under section 199A of the Internal Revenue Code (section 199A deduction).

Of course, you do have to meet certain requirements in order to qualify:

As such, the deduction isn’t available to:

  • C-Corps
  • Income earned as an employee providing services
  • On properties with triple-net leases

Not unlike many deductions, there are also income thresholds which as of 2021 were:

  • $329,800 for Married couples filing jointly
  • $164,900 for all others

and for 2022 will be:

  • $340,100 for Married couples filing jointly
  • $170,050 for all others

How the QBI Deduction Works

Calculation of the deduction involves 2 components:

  • QBI – 20% of QBI from a domestic business meeting the ownership criteria discussed above, subject to the following limitations:
    • 50% of W-2 wages paid to employees of the business.
    • Or 25% of wages paid to employees of the business plus 2.5% of unadjusted basis immediately after acquisition (UBIA) of qualified property held for trade or business

Like much of the IRS code, section 199A can be quite convoluted. There are limitations and qualifications which can be difficult to navigate successfully. Having someone like HKMP, with extensive knowledge and experience with the IRS tax code, can ensure you meet all necessary criteria, your deduction is calculated correctly, and you don’t miss out on every opportunity for potential tax savings.

Protect Your QBI Deduction. Cover All the Bases.

Qualifying for the safe harbor isn’t just about meeting requirements for a qualifying business or understanding the thresholds which limit the deduction. There are specific record-keeping requirements which must be met as well:

  • Maintain separate books and records reflecting income and expenses for each property
    • Owners of multiple properties can satisfy this requirement by preparing separate income and expense statements for each property before consolidating.
  • Investment enterprises in existence less than 4 years must have at least 250 hours of service performed by the taxpayer or others for:
    • Plumbing
    • Landscaping
    • Landlord-related duties such as
      • Repairs and maintenance
      • Rent collection
      • Application review
      • Time spent with tenants
  • Ensure a record of all services performed includes:
    • Hours
    • Description
    • Dates of service
    • Who performed the service

In addition, you must attach a statement to your tax return for every year you rely on the safe harbor.

Enlisting HKMP’s help can ensure you comply with all the safe harbor requirements, maximize your deduction, and avoid jeopardizing the deduction now, or in the future.

The Importance of an Annual Financial Review

If you’ve ever been through a financial audit, you know they are time consuming and exhausting. Not to mention expensive. What if you could reduce the possibility of needing audited financials? Fortunately, you can. The answer is an annual financial review. They are less time consuming, less costly, and take less time away from you and your staff’s day-to-day business.

As a business owner, you accepted an element of risk the day you decided to launch your business. Continually monitoring and managing that risk affects every decision you make; every relationship you form.

Though annual reviews can help reduce your need for an audit, there are times an audit may be unavoidable, such as:

  • Financing for business expansion
  • Compliance

If you’re talking to lenders or investors about funds for expansion, you can be certain they’ll want reasonable assurance you’re worth the risk.

Depending on the nature of your business, and the industry in which you operate, you may be required to provide regular, audited financial statements to a government regulator. When audited financials are required, the auditor’s opinion is the assurance needed to provide a high level of confidence your company’s financial statements and disclosures conform to generally accepted accounting principles (GAAP) in the United States of America are presented fairly, and are free from any pertinent misstatements. However, if none of this applies to you, you might want to opt for reviews rather than audits.

How is an Annual Financial Review Different from an Audit?

A review is an examination by a CPA, where the auditor evaluates financial data to provide moderate assurance that they are not aware of any material modifications that should be made to the accompanying financial statements in order for them to be in accordance with GAAP. Due to the limited scope, a review has significantly less impact on time spent by staff and management than an audit.

While an audit and a review differ in their scope, they both consist of a systematic examination of the inputs to the financial statements in order for the accountant to provide a report which will, hopefully, state that the financials are free of material misstatements, and are prepared in accordance with GAAP.

HKMP can help you determine if, and when your company requires an external review.

Choosing the Right People for the Job

Audits and reviews must be performed by an independent, outside CPA.

Not every CPA firm is qualified to perform an audit or review. When the time comes for you to invest in an audit, you’ll need a firm who is experienced in your industry and understands your business. Although it could be the same firm who performs other services for your company, they must be able to maintain a position of independence throughout the audit.

It’s also important you feel confident they have a solid reputation, qualifications, and staffing to perform the audit efficiently. You need to ensure you’re ready for the process to begin, and avoid unnecessary, and often costly delays.

HKMP has the knowledge, experience, and reputation to ensure both audits and reviews are performed professionally, and efficiently. As such, they can advise you as to which process best serves your needs.

Prep Tips to Simplify Your Business Taxes

Tax Preparedness

Whether you’re a seasoned pro, or it’s your first-time filing taxes for a business, there are commonalities in what your tax preparer will need to ensure your returns are complete and accurate. Using a checklist will not only save time, but will help your tax professional find all the deductions and credits to which you’re entitled, giving you the lowest possible tax bill. Who doesn’t want to simplify their business taxes and pay less?

First and foremost, you should already have some form of business accounting system in place, capable of tracking your transactions, and generating reports. If you’re just starting out and have a minimum number of transactions, you might be able to keep it simple, using a spreadsheet, or Quicken.

However, you’ll pay for the simplicity by having to migrate to something more robust as your business grows.  Options for sole proprietors, freelancers, and very small businesses include Fresh Books, and Wave, both of which are recommended by Investopedia, Nerd Wallet, and PC Magazine.

If you’re growing, and have, or intend to have payroll, you might prefer something that will grow with you. Top picks include Xero, Quickbooks Online, and Zoho. Prices, functionality, integration and available modules vary from one system to another. For best results, and to avoid the perils of migration sooner than necessary, let HKMP help you determine which system will suit your needs and your growth, and provide the best overall value.

Checklists Simplified

Once you’ve entered all transactions for the year into your chosen accounting system, you can prepare the following reports:

  • Income and Expense (aka P & L)
  • Balance Sheet
  • Statement of Cash Flows
  • Previous Year’s Tax Return

This will help your tax preparer determine where additional detail is needed. You can start by providing detail for the following areas:

  • Assets purchased, depreciated, or disposed of
  • Loans
  • Leases
  • Opening and closing inventory, if applicable
  • Stocks or bonds purchased or sold
  • Payroll reports

Much of this information will also be useful when  tax planning during Q4 of 2022.

Information about your loans may be a little trickier this year if you took advantage of the Paycheck Protection Program (PPP), or Economic Injury Disaster Loan Program (EIDL). Though they may be excluded from income, it’s important to report them accurately so you won’t pay unnecessary taxes on funds which helped keep your business afloat amidst the challenges imposed by COVID regulations.

Detail Made Easy

Other areas for which you might be asked to provide detail are:

  • Officers’ salaries (corporations)
  • Guaranteed payments to partners (partnerships)
  • Dividends received broken down by payer
  • Taxes and licenses
  • Professional fees
  • Interest
  • Charitable contributions

Most of the accounting programs mentioned can create schedules by payee which will satisfy your accountant’s needs. Make sure your detail includes the tax year for which your tax payments were made so any pre-payments are applied correctly.

Staying Tax Prep Ready

Tax preparation shouldn’t be something you ignore until it’s time to give your records to your tax accountant. There are a number of ways to stay ahead of the curve so your accountant can not only prepare your tax returns, but help you with tax planning before the year is over. Above all, they’ll help simplify your business tax information gathering process and the transmitting of required filings at tax time.

  • Adequate accounts for collection of costs and income (e.g. Officers’ Salaries and bonuses separate from Employees)
  • Maintain up-to-date schedules for:
  • Taxes and licenses
  • Depreciation
  • Stocks and bonds
  • Reconcile accounts at least quarterly, if not monthly

Keeping your books and records up to date will enable you to schedule a tax planning appointment during the fourth quarter. There are many opportunities to improve your tax position in both the current, and subsequent year. Don’t lose out on many tax saving strategies by failing to act before the end of the year.

Make HKMP your one-stop-shop for accounting, tax planning, and tax preparation.

Strategies To Minimize Tax Liability For Business Owners

As a business owner, you strive to run a profitable, thriving business. But you’re not in business to support the IRS, so how do you avoid paying more than your fair share? As in life, knowledge and information are your best defense, and your greatest assets for ensuring profits remain available for business expansion, including capital purchases, and increased staff.

By now, you’ve probably closed the books on 2021, and are setting your sights on a strong, profitable 2022. You still have time to take advantage of options to minimize your taxes for 2021, and implement tax efficient strategies for 2022.

Your first line of defense is to hire a knowledgeable accountant like HKMP who can help you navigate the muddy waters of the tax code, avoiding costly mistakes, and taking advantage of strategies to minimize your tax liability.

Make the Most of Depreciable Assets

If you’ve purchased tangible capital assets such as machinery, vehicles, computers, or cell phones, consider taking advantage of Bonus Depreciation and/or the Section 179 deduction. Both allow you to accelerate depreciation on new, or used equipment by deducting up to 100% of the cost in the year of purchase. You can also deduct up to 100% of a capital lease in the first year, although you spread the purchase price over multiple years.

Section 179 does contain certain limitations:

  • You must show a profit for the year
  • A maximum deduction of $1.05 million in 2021 and $1.08 million in 2022
  • Maximum equipment purchases of $2.62 million in 2021 and $2.7 million in 2022
  • Smart phones and laptops available for personal use have a 50% limit
  • Vehicles available for personal use have an $11,600 depreciation limit in the year purchased

Bonus depreciation gives you a little more leeway, especially since the limit increased from 50- to 100-percent in 2021. Be aware, the limit will begin decreasing in 2023, until it bottoms out at 20% in 2025. Also, if you take Bonus Depreciation on one asset in a class, you must use it for all assets in that class purchased in the same tax year. Here is where a conversation with your accountant is imperative so you take full advantage of the tax benefits.

Key advantages to using the section 179 deduction:

  • Flexibility
  • You can use all or part of an assets cost
  • Can be used for different classes of assets
  • Does not need to be used for all assets in a class
  • Can be used for Leasehold Improvements

Key advantages to using Bonus Depreciation:

  • You don’t have to show a profit for the year
  • No upper limit on purchases, or bonus depreciation claimed

Above all, you can use both the Section 179 deduction and Bonus depreciation in the same year. Just make sure you’re not applying both to the same asset.

There are other considerations affecting how and where you use Bonus Depreciation and the Section 179 deduction so it’s critical to discuss your options, and best course of action with your tax accountant. Some slippery slopes include:

  • Recapture rules
  • When you have to opt out of Bonus Depreciation
  • Section 179 ceilings on deductions and annual purchases
  • Changes in the allowable percentage of Bonus Depreciation after 2022

Now is the time to plan your future capital purchases, to ensure you’re taking full advantage of the tax savings both options offer.

Accelerating Depreciation on Real Estate

If you invest in real estate, you may want to consider cost segregation to help you pay little or no taxes on your investments. Cost Segregation is a tax strategy that allows real estate owners to utilize accelerated depreciation deductions to increase cash flow and reduce both federal and state income taxes on their rental income.

By breaking down, and reclassifying certain interior and exterior components of a building to personal property or land improvements, you can take advantage of accelerated depreciation Instead of depreciating the entire building over 39 years for commercial property, or 27.5 for residential property, you can depreciate the portions you break out over 5, 7, or 15 years.

Let HKMP help you decide how best to apply these strategies to minimize your tax liability for 2021 and beyond. They can provide invaluable insight, so you optimize all available tax saving opportunities. They’ll guide you through the constantly changing landscape of tax law, helping you use those changes to your advantage, and avoid costly mistakes in the future.

Year-End Tax Planning Gives You the Advantage

Make Tax Planning Part of Your Year End

…in this world, nothing is certain except death and taxes.  – Benjamin Franklin

Filing and paying annual income taxes may be an integral part of doing business, but that doesn’t mean you have to like it, nor pay more than your fair share. Whether you face the task with acceptance, resignation, or dread, you know it’s inevitable once the year ends, and you close your books. The question is, when do you start to address your year-end tax planning?

Running a successful business means keeping abreast of new rules, laws, regulations, and lately, mandates which impact not only costs, but how you manage both day to day, and long-term activities. You have enough on your plate without trying to keep up with the changing environment for income taxes too.

Your customers or clients depend on you to be the expert in your field. Call on HKMP to keep you abreast of changes in tax laws which impact you both positively and negatively, allowing you to focus on your own areas of expertise, while protecting your business interests, and cash flow. Don’t miss the opportunity to take advantage of HKMP’s expertise to review your books and records prior to year-end, and advise you of opportunities to minimize your tax liability. Our knowledge and experience will ensure you make informed decisions like scheduling expansion, and major purchases in years when tax laws are more favorable.

Take Advantage of the Right Timing

Timing is everything. Whether it’s capital investments, year-end bonuses, hiring, or inventory, you want to make informed decisions. In many of these areas, you’re already doing your research, and mapping out a plan before reaching final decisions. Yet all too often, the impact on both your current and future tax liability is overlooked. In many ways, it’s as important as ROI.

One area which has seen significant change over the last 40 years or so is depreciation. Not only have Section 179 limits changed over the years, but so have limits on first-year depreciation. Looking back, a mere 13 years, the Section 179 limit has grown from $250,000 in 2008 to $1,050,000 in 2021. Not all years have seen increases, but don’t you want the option of deciding whether to escalate or delay a major purchase if the limit increases the following year?

Many companies experienced decreased revenue, and increased costs for the last two years thanks to COVID. As you prepare your budget for 2022, knowing how those costs will affect both actual and projected net income will keep more money in your pocket. Better still, you’ll have more money to spend on the original dream with which you launched your business in the first place.

Year-end tax planning areas

Protect Your Investments With Year-End Tax Planning

Would you wait until January of February to create next year’s budget? Probably not, as you know you’d start the year blind to objectives and opportunities. You don’t wait until January or February to start making estimated tax payments either, as you don’t want your cash flow to take one, large hit. You certainly haven’t achieved your current level of success by ignoring the numbers, or failing to see how they measure up to your projections and expectations.

Tax laws can be shark-infested waters. If you’re unprepared, they can bite off far more than you’re willing, or even able at times, to give. Knowing there’s an expert ready to take the wheel and guide you through those waters unscathed protects your assets, leaving you free to focus your attention and resources on the present challenges, and future opportunities.

Ask yourself this. If your dream was important enough to create a plan, and map out at least part of the route to making it a reality, isn’t it equally important to allocate time, energy, and resources to protect what you’ve built?

Scout Ahead to Minimize Setbacks

To put it simply, year-end tax planning is the security team’s scout who heads out before dawn to ensure the way forward is clear of perils and pitfalls. He alerts you to blocked roads, washed out bridges, and potential ambushes, giving you time to set up defenses, and re-map your route. Without him, you’d walk right into those ambushes, or find yourself mired in quicksand, causing expensive delays and missed opportunities. Clearly, the money you spend on his services will be recouped many times over.

You could choose to fly by the seat of your pants, hoping your business grows, and thrives. You can navigate the expensive mistakes, in the belief they’re simply a cost of doing business. Or you can build a team which includes people who are there to protect what you’ve built, and clear the way forward. I’m guessing you didn’t take unnecessary chances when you first started out, nor did you try to do more than you had to by yourself.

If you’re ready to clear a few obstacles from your path, HKMP is the scout you need to navigate the tax waters, and avoid the sharks.